Saturday, July 12, 2008 at 08:31AM
Mortgage Credit Crunch
From Brad Inman, Inman News:
In 1974, the United States was reeling from Watergate and the Vietnam War and stuck in a vexing recession. Inflation was out of control and President Gerald Ford was struggling to get control of the country and its economy. A collectible from those days is a "WIN" button, which stood for "Whip Inflation Now" -- a promotional device that the desperate Ford administration ginned up.
At the time, I was fresh out of college, living in Peoria, Ill., and working as an urban planner. One distinct memory I have was passing the downtown office of Peoria Savings with a sign on the window that read "No Home Loans."
A moratorium on home loans -- can you imagine?
Get ready.
In the early 1970s, the housing market had no meaningful secondary mortgage market. When passbooks savings -- which capitalized most mortgages -- shrank, money for home loans dried up.
In 1968, Fannie Mae and Freddie Mac were re-chartered by Congress as shareholder-owned companies funded solely with private capital raised from investors on Wall Street and around the world. But it was not until the 1980s that they found their footing and their growth mushroomed. Mortgage-backed securities got traction in the early part of this decade with the national push for home ownership. New mortgage instruments were invented to capture global interest in U.S. home loans.
In this period, a secondary market came onto the scene with brute force. By 2005, the size of the market had ballooned to $3 trillion.
And today? It has collapsed. Even Fannie Mae and Freddie Mac are poised for a government bailout. Today, Fannie Mae's stock has tumbled 45 percent and Freddie's has fallen 20 percent. This is after steep declines all week.
So, imagine a return to a housing market without a robust and functional secondary housing market. In other words: a severe credit crunch.
Here are 10 things that I predict will flow from its collapse (many of which have already hit the beleaguered housing market):
1. The capital that exists from direct lenders such as community banks, savings institutions and large commercial banks will fall short of potential demand and focus on bread-and-butter loans, leaving most borrowers out in the cold.
2. Exotic loans of any kind will be completely out of favor, leaving many borrowers and many properties unfundable.
3. Home sellers will become active lenders, but only those who have equity. Seller financing will help some transactions.
4. Second homes, expensive houses and certain types of investment property will be penalized and difficult to fund.
5. Small boutique lenders will enter the business, capitalizing on market voids, funding specialized but secure niches.
6. Investment banks will take care of unleveraged high-net-worth customers, but terms will be unfavorable so this market will further shrink.
7. Sovereign wealth funds are not the solution, because many were burnt on mortgage-backed securities.
8. Those that do lend will revert to back-to-basics underwriting: perfect credit, large down payments, proof of income, personal character and good family upbringing.
9. Housing industry lobbyists will make the mortgage liquidity problem their number one policy issue in the next two years. They will argue that the sky is falling and it is.
10. The trend will keep the housing market starved for capital, prolonging the slump.
Like so many parts of our American culture, the accessibility to unlimited and poorly scrutinized debt helped turn Americans into a sloppy group of consumers, which spawned greedy Wall Streeters, out of control lenders and starry-eyed investors.
Jim the Realtor
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Reader Comments (19)
If Fannie and Freddie fail or get bailed, funding real estate transactions will be the least of our problems. A GSE failure is pretty much a white dwarf scenario - the end of life as we know it in America, that's for sure. Why? Because the dollar will become worthless and us SoCal'ers will be begging for pesos down in TJ.
In the words of our illustrious leader, "Bring em on!" Us savers would think we're in Utopia if our Gov't. actually refused to subsidize and bail out our corrupt Banks, Speculators and the ever-whining NAR. Is it too much to hope that we'll reach a time when borrowers can't walk away from their loans on a whim?
For 12 years this Administration & the prior one has given every break to every contibutor & every sniveling special interest imaginable. Isn't it long overdue SAVERS get a fair shake?
Great synopsis, Jim. I think you hit the nail right on its head. The so-called "American Dream" of homeownership, pumped and hyped by our government, is about to die for most of America.
Doug - Understand, if the GSE's fail or get bailed the dollars in your piggy bank will be worthless. If you were smart enough to accumulate gold or barrels of oil instead of cash then you might be OK...that is if you can get out before the commonwealth confiscates it.
Looks like we may see a return to "subject to mortgages" and "land contract sales." The snake oil salespeople will make bank!
I just looked up jumbo rates from Schwab, which has always been pretty competitive, and they are showing jumbo rates ( > $417K, not just over the new higher limits) in the 8%-9% range (link).
Are you guys seeing the same thing? I can't image how anything will sell in coastal north county.
As in past history, the sky is black, but one day there will be loans and more homeownership. Just not the zero down type. It may be a while, but I thought in 1980 when rates were 20% it was all over too. It will rebound. Just may take 10 years this time. These greedy stupid bankers and borrowers really screwed it up for us this time.
If I may summarize Jim's 10 predictions in a single sentence: "A return to common-sense in lending practices". Its a waste of time to preach to a junkie. You need to let them hit rock bottom before they want to get better.
I have the ability for a 50% cash down, great credit, documented income and stand ready to buy. I'm just not prepared to provide a 200k gift to a home seller, just lower your price.
Don't higher rates and less access to cash improve my position? As for the devaluation of the dollar, does this not make imports more expensive and improve the position of the American worker and good? Yes, I agree it does hurt the US multinational that has outsourced labor or manufacturing.
"Because the dollar will become worthless and us SoCal'ers will be begging for pesos down in TJ."
I don't follow your logic.
The amount of money needed to "bail out" GSE's and to keep them functioning as intended is on the order of $10 billion / year, at most (with a 'b'). In the grand scheme of things, that's spare change.
I just looked up jumbo rates from Schwab, which has always been pretty competitive, and they are showing jumbo rates ( > $417K, not just over the new higher limits) in the 8%-9% range (link).
IIRC there are jumbo rates and there are "jumbo-conforming" rates. It's harder to qualify for a "jumbo-conforming" loan, but your interest rate will be a fixed percentage over the conforming rate (usually 0.25% or 0.50% depending on terms, credit score, etc)
SD Scientist,
Where are you getting the $10B number?
Not disagreeing, just would like to know more about the details.
Thanks!
9% interest rates are hardly the end of the world. It's more like the heartburn you get as a deserved penalty after eating a rich, heavy meal. A return to rational lending standards is a good thing, not a bad one. An end to rampant fraud and speculation in real estate is also a good thing, not a bad one. "We" as a society (not "us" as a blog community) allowed this to happen -- seems to me a lot of the bad things that come our way do so because we asked for them.
I bought my first house in 1983. The 30-yr fixed mortgage was 13%, and was pretty much at the limit of what I could afford. The payments came steadily down from there, as I refinanced it every 2-3 years over the 15 years I owned it, the last time at 7.5% in 1997 (the year I sold it). What made buying with a high-rate mortgage work for me was waiting out the bust of the early 80's until prices had started to come up again. I missed "buying at the bottom" by a year, but by the time the next bust hit the house had come up enough that I was in no danger of going underwater.
An extremely well written analysis without political shrillness. Whether GSE's survive or not, the "We have a Right to plenty of Cheap Credit" attitude is gone. Home prices will automatically track the new reality of fewer buyers and scarce credit.
Saving will be back in fashion and Spending will be less sexy. Expect fewer ipods, handbags, Nikes etc., Lower real wages in U.S. (and higher wages abroad, at least when measured in depreciating US $) and higher transport costs will slow down offshoring and may bring back some manufacturing.
Where are you getting the $10B number?
Total interest payments on Fannie and Freddie bonds, combined, are approximately $80B/year. (E.g. see Freddie Mac's annual report, page 36) Normally they collect more money in mortgage payments than they spend on bonds.
Unlike Countrywide and IndyMac, GSEs have solid portfolios, their delinquency rates are on the order of 1%.
Worst case scenario, if GSE delinquency rates go up to 10% and they don't recover ANY money through foreclosures, they'd require government infusions of $8 billion/year to function.
That's why I'm baffled by all this talk about GSE's being "insolvent" because their net paper asset value is supposedly negative.
Maybe it's just me, but every point you list seems like a positive for the housing market, and something which I would personally vote for if I was allowed/enabled to choose the direction for the market. I would add one, though:
11. Housing will become much more affordable. With no exotic loans, rates set by the market, and credit qualifications based on actual risk instead of expected bailouts, housing will finally be within reach of normal Americans, without exotics loans or banking on asset value appreciation. The actual percentage of households owning houses will rise, and they will actually be able to own them indefinitely, based on real assets and income.
I fail to see why that's a bad thing, but maybe that's why I'm not running the country.
Just a note - the above piece was authored by Brad Inman, long-tine real estate broker and currently running Inman News.
I'll add one comment to the original post which is largely true at a macro level:
Lending will return first (and soon) to the regions of the country that are experiencing demographic flow. Those markets never bubbled and are now already stable or climbing in price (NE, OK, TX, NC, the Mid-South, etc.). The regional players in those markets will benefit from larger spreads and will expand into other markets as they bottom and risk of collateral loss decreases. These companies will become the next Countrywides of the recovery. And the cycle will repeat. Let's hope at a lesser extreme the next time.